Thursday, January 6, 2011

A Look at the Old Shell Game: Reverse Mergers From China and Russia (CGA; SGAS; QING; AGVO; AMOK)

Yesterday's post on China Green Agriculture reminded me of a Barron's column from last week:

Mergers That Don't Enrich Shareholders

Reverse Mergers of Chinese companies continue to sag

We were on to something when we warned investors against the hundreds of Chinese businesses that had their shares listed on U.S. exchanges through the back-door technique of reverse-takeovers ("Beware This Chinese Export," Aug. 30, 2010).

The stocks have been poor performers. Two weeks ago the Wall Street Journal reported a wide-ranging investigation by the Securities & Exchange Commission, which is looking into the supply chain of stock promoters, bankers and accountants who have brought public some $50 billion worth of such stocks by merging China ventures into publicly traded American shell corporations. Congress members have vowed to hold hearings. On Dec. 20, the SEC fined a California audit firm featured in our story -- Moore Stephens Wurth Frazer & Torbet -- which agreed to a bar from auditing additional public-company clients in China, Hong Kong and Taiwan.

But that modest action by the SEC may be the only regulatory effort that investors can expect for quite a while. People with first-hand knowledge of the SEC's inquiry say that its investigators are worried about the expense of probing overseas businesses, especially because the agency can't subpoena evidence from China.

Warning Still Applies

Since our story in August, the median reverse-merged China stock has lagged the Halter index by 14 percentage points.

Investors don't need evidence of securities violations to conclude that reverse-merged China shares are lousy stocks. Our August story showed that the median performance of this type of stock was about 75% worse than the Halter USX China Index, an index of U.S.-listed Chinese companies. Since August, the shares have continued to underperform. Most of the 350-odd group that we studied are now penny stocks. Considering just the 127 of those stocks whose share prices were above a buck back in August, the group's mean return over four months has been flat. The median stock in the group lost 1.7%. By comparison, the Halter Index has gained about 12% since August. The Nasdaq and the Russell 2000 have gained about 25%.

The riskiness of reverse-merged shares has as much to do with the American side of the reverse-merger business as it does with the Chinese.

Consider some stocks assembled by Belmont Partners, a Washington, Va.-based investment-banking outfit. The firm says it has supplied publicly traded shell companies for more than 160 reverse-merger transactions, with a total market capitalization in excess of $2 billion. Dozens of those reverse mergers involved Chinese enterprises like China Green Agriculture (CGA) and Sino Gas Holdings (SGAS), both of which sold off sharply in 2010. Belmont Partners' founder Joseph Meuse created the Reverse Merger Association of America in 2008; the same year his firm held a conference featuring Alan Greenspan as keynote speaker....MORE

Oh happy day.
Long time readers know I have a morbid fascination* with the underbelly of the markets; it's like watching the lions approach the wildebeest at the watering hole, you don't want to see it but you can't look away.

As they say on the nature shows:
"Sadly now, there can be but one outcome"

From the Wall Street Journal:

The SEC's Russian RouletteIPOs From Ukraine and Russia Were Cleared, With Few Questions Asked

On Jan. 6, 2009, Ukragro Corp. of Zhitomir, Ukraine, made an initial filing with the Securities and Exchange Commission to sell stock to the public. Its sole employee and owner was a 79-year-old massage therapist.
The company had no revenue, $100 in assets and planned to open a string of health spas. Public records on file at the SEC show that the agency asked no questions and the application cleared through the commission eight days later.

Over the past two years, eight other start-ups reviewed by the SEC have been similarly headed by people in Ukraine or Russia, with no revenue or operations and minimal assets. Business plans ranged from renting bicycles in Kiev to selling cars in Siberia. All used the same small Seattle law firm, Dean Law Corp., to help with their initial SEC filings. The SEC cleared them to sell stock, in most cases without asking a single question, according to the public records at the agency.

The SEC declined to comment on its reviews of individual companies. John Nester, a SEC spokesman, said the agency's chairman, Mary Schapiro, has been "aggressively pursuing enforcement actions" and "is changing the direction and culture of the agency." Ms. Schapiro, for example, has formed a new division with broad powers to identify risky market practices, such as the trading of complex derivatives, and is trying to secure more resources.

In an email response to questions, Faiyaz Dean said his law firm's involvement with the companies "ended after our limited engagement of providing a legal opinion for their registration statements. Other than this, we are bound by attorney-client privilege and cannot answer any further questions."

The ease with which these companies—known as corporate "shells" because they didn't yet have operations—sailed through the SEC raises questions among some observers about the agency's ability to police the market for small-company stocks. Given that the shell companies "appeared to have little or no business results or experience," their filings should have been carefully reviewed for evidence of possible fraud, said Joel Seligman, president of the University of Rochester and author of a history of the SEC....MORE